How to Prepare Clients for the New Tax Changes | Lord Abbett

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Practice Management

Despite questions about the hastily cobbled legislation, there's some consensus as to what advisors and their clients can do now to avoid unpleasant surprises.

This Practice Management article is intended for financial advisors only (registered representatives of broker/dealers or associated persons of Registered Investment Advisors).

Advisors who want to help their clients prepare for the new tax law can breathe a sigh of relief: the changes won’t affect taxpayers for the 2017 filing season.

That’s news to about 41% of the 2,000 Americans recently surveyed by tax prep chain Jackson Hewitt—they thought the tax law President Trump signed in December 2017 would affect their filings this season (among millennials, it was 50%).

It should come as no surprise, then, that tax preparers and financial advisors are girding for a barrage of questions from clients about what they should do right now. As these experts scramble to educate themselves, the opaque nature of the new law and its unanswered questions (it was rushed through Congress so fast that some changes were scribbled on the margins) have even left them confused.

“I attended my second tax update for CPAs today where the instructor completely contradicted what we heard last week at a similar session,” said Evan Beach of Campbell Wealth Management in Alexandria, Virginia.

Nevertheless, there is some consensus as to what advisors and their clients can do now. Below are some early thoughts from wealth managers on strategies taxpayers can start thinking about to avoid unpleasant surprises a year from now.

1. Preview 2018 Taxes

Advisors suggest having an accountant run mock 2018 returns after this year’s forms are finished. TurboTax’s TaxCaster tool, for example, was just updated to be able to forecast a 2018 tax refund based on the new law. To use the tool, individuals enter their basic 2017 tax information, and it will spit out a 2017 estimated refund and a forecast for 2018 side by side, according to the company.

H&R Block said its preparers will get a “pretty detailed” tool in the first week of February to allow them to go over a finished 2017 return, line by line, and preview the new tax law’s impact on next year’s return. TaxAct expects its calculator to be updated by mid-February, such that it can preview next year’s taxes.

Running those future numbers can flag potential issues. That said, state revenue departments and the Internal Revenue Service (IRS) have had little time to process the changes, because so much remains in flux. “The IRS and states haven’t decided how some provisions of the new tax law will be calculated yet,” said Jagjit Chawla, general manager of Credit Karma Tax. “For example, they only recently shared guidance with tax preparers about the current 2017 tax season. The IRS and states will share their 2018 guidance later this summer.”

2. Rework Your Client's Withholding

The new law means that the W-4 your client filled out however many years ago may need to be recalibrated. The IRS came out with new withholding tables on January 11 that reflect changes, such as the elimination of personal exemptions in the new tax law, but has yet to release an updated withholding calculator or a revised W-4 form. In addition, the new tables don’t reflect all the changes that may affect a taxpayer next year, so the tables are somewhat of a blunt tool.

If workers leave their W-4 as is, they could wind up withholding too little, which can bring penalties, or they may get a smaller-than-expected refund next year. Workers in higher tax brackets who receive large bonuses could see a higher tax bill next season if they don't tweak W-4s, since one of the ways employers can set the withholding rate on “supplemental income” such as bonuses in the new law is to use a flat rate of 22%.

“A large percentage of our clients will see a tax increase due to being in a high-property and high-income tax area,” said Beach. “My fear is that the new withholding tables will have them under-withhold, and then they will have to write a check in April.” The only solution he sees to deal with that now is for clients to make quarterly estimated payments.

H&R Block expects its new tool to help people figure out if they need to change their withholding, and Liberty Tax Service is crunching on a new calculator to let those who get W-2 and 1099 forms make sure their withholding is appropriate. The goal is for the calculator to be ready for the later part of the filing season, which starts around March 1, said Martha O’Gorman, Liberty Tax Service’s chief marketing officer.

3. Watch for SALT Workarounds

A big change that could affect many taxpayers is the tax overhaul’s controversial cap on state and local income tax (SALT) deductions, a provision Democrats have labeled a war on blue state Americans. The deduction, which used to be unlimited, will be capped at $10,000 next year. The new law’s near-doubling of the standard deduction, to $12,000 for single filers and $24,000 for married couples filing jointly, does mean that fewer taxpayers will itemize deductions, but residents of high-tax, high-income states, such as California, New Jersey, and New York, could wind up paying thousands of dollars more. A report by New York State’s Department of Taxation and Finance pegged the cost to New Yorkers alone at $14 billion.

States are busy devising workarounds to try and keep those residents from seeing a big spike in federal taxes next year—or moving to a lower-tax state. Strategies being explored include plans to replace a state income tax with an employer-side payroll tax, and/or a system of tax credits for charitable donations made to state funds that support areas like education and health care. It’s not clear whether the attempts will prove administratively or legally feasible, however, especially since the Trump administration has pledged to fight such efforts.

4. Bunch Up Your Client's Donations

To try and get around that new SALT limit, one strategy advisors suggest for clients who regularly donate to charity is to bunch up into one year what they would have given over multiple years. For those who itemize, charitable donations remain deductible on federal returns and can help lift married taxpayers who file jointly above the $24,000 standard-deduction hurdle. By putting a few years’ worth of donations into a donor-advised fund—many financial services firms have units that offer them—clients can take the deduction the year they put the money in, but distribute the money to charity over multiple years.

5. Home Equity Loan Deductions

The deductibility of interest on home equity loans and lines of credit (HELOCs) is a big area of confusion, said Tim Steffen, director of advanced planning for Baird Private Wealth Management. The new tax law lowered the amount on which interest expense on so-called “acquisition indebtedness” could be deducted—from $1 million to $750,000 for new loans made after December, 14, 2017. It also eliminated the interest deduction on loans that are not used to “buy, build, or substantially improve” a home, he said.

“Sometimes people buying a home don’t have money for the down payment, so they take out a loan for 80% of the price and a home equity loan out for 20%,” said Steffen. “Because the home equity loan was used to buy a house, it’s still considered deductible.” Going forward, though, if clients take out a HELOC and use some of the money to buy a car, they cannot deduct that interest. If they use the money to put an addition on their home, however, that may still be deductible.

6. New College Savings Plan Uses

The new tax law expands the allowable use of tax-exempt 529 college savings plans for education costs that accrue while a client's child is between kindergarten and high school graduation. But while some states automatically follow the federal code, others choose to decouple from certain parts of it. So, while the U.S. government may say taxpayers can use 529 money for K–12 expenses, a state may consider such a withdrawal a nonqualified distribution and could charge you penalties, said Steffen. So be careful.

7. Run Your Client's Retirement Numbers

A question Scott Bishop of STA Wealth Management in Houston is hearing is whether the tax law does anything good or bad for a client’s retirement strategy. For those retiring before age 70½—the age when withdrawals from tax-deferred retirement savings plans such as 401(k)s become mandatory and thus raise their taxable income—lower tax rates could present a reason to convert a standard pretax IRA into a Roth IRA, which consists of aftertax money. Or clients may consider taking distributions from standard IRAs, which they can tap without penalty starting at age 59½, in order to take advantage of lower tax brackets and avoid a “tax time bomb” of having to take large required minimum distributions (RMDs) while in retirement. Those bombs can bump your clients up into a higher tax bracket.

—by Suzanne Woolley, Bloomberg News


The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances. The information contained herein has been provided by sources other than Lord Abbett which are believed to be reliable; however Lord Abbett cannot guarantee the accuracy or completeness of this information.

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